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Answer: Printing money to pay its local currency debt can be useful for a country in the short term, but can result in serious economic consequences in the long term.
The correct answer is D. When a country is at risk of defaulting on its local currency bonds, it may be tempted to print more money to pay off its debts. This can be an attractive short-term solution because it does not immediately affect the country's reputation or credit rating. However, in the long term, printing more money can lead to serious economic consequences such as currency devaluation and inflation. Option A is incorrect because a country's local currency rating is usually higher than its foreign currency rating by one or two notches. This is because local currency bonds are considered less risky since they are denominated in the country's own currency. Option B is incorrect because most instances of foreign currency sovereign debt default involve some form of debt restructuring, where old bonds are exchanged for new bonds with a reduced net present value. This means that investors do not necessarily lose the entire value of their investment upon default. Option C is incorrect because foreign currency debt is often purchased by global banks and other international lenders, not just investors based in the issuing country. This broadens the investor base and increases demand for the bonds.
Author: LeetQuiz Editorial Team
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A newly hired fixed-income dealer at a major bank that specializes in dealing sovereign bonds from various countries is tasked with understanding the differences between sovereign bonds denominated in foreign currencies versus those in local currencies. Specifically, the dealer is investigating how these differences impact the risk of default and the perception of these bonds by investors. What would the dealer find to be true in this analysis?
A
A country's foreign currency debt rating is typically higher than its local currency debt rating.
B
Investors in foreign currency sovereign bonds typically lose the entire value of their investment upon a country's default, whereas investors in local currency bonds do not.
C
Debt issued in foreign currency is usually sold to investors based in the issuing country.
D
Printing money to pay its local currency debt can be useful for a country in the short term, but can result in serious economic consequences in the long term.
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